Bond spreads have moved up significantly this year, with a sell-off this past week. Some of the underlying factors seem to be well-known in the market for a while. Why the sell-off now?
closed as primarily opinion-based by ChrisInEdmonton, MrChrister, Dheer, Robert Cartaino♦ Dec 14 '15 at 17:28
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This is more of an economics question really but it does also affect personal investing.
The major reason for the dramatic fall on Friday was that, due to losses, a significant sized junk bond fund run by Third Avenue was barring redemptions. This caused the markets to panic thinking that they were about to close the fund and sell all of their holdings so other traders wanted to "get in first" and crystallize their P&L. Barring redemptions is a very rare move.
Further falls today have been caused by the bearish sentiment following that decision taking over the market. Fearful investors are pulling their money from junk funds meaning that the funds have to liquidate assets. Their sell-offs cause prices to fall further and that spooks even more investors. Sell-offs are contagious; investors see falling prices and a weaker outlook for instruments and try to get out of the market. This pushes the prices lower making the outlook even worse for the assets and causing more people to sell - this is a typical crash in that respect.
The factors contributing to the long term decline are that the low price of oil is depressing the value of debt surrounding US shale gas exploration and production and that the market expects the risk free rate to rise. When the risk free rate (US fed rate) rises yields on all types of bond rise as the return on a bond is the risk free rate plus a risk premium. Since bond prices are the inverse of yields it follows that an increase in the required yield results in a fall in the bond's price. They will be big factors in Third Avenue's losses and decision to bar redemptions.